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Chapter 21. MARKETS FOR CORPORATE SENIOR INSTRUMENTS: II. Corporate Senior Instruments. Corporate Bonds Classified by type of issuer: ‘industrials’ > banks/finance companies > utilities Investors: life insurance companies, pension funds (mostly institutional) Preferred Stock.

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Chapter 21 l.jpg

Chapter 21

MARKETS FOR CORPORATE SENIOR INSTRUMENTS: II


Corporate senior instruments l.jpg
Corporate Senior Instruments

  • Corporate Bonds

    • Classified by type of issuer: ‘industrials’ > banks/finance companies > utilities

    • Investors: life insurance companies, pension funds (mostly institutional)

  • Preferred Stock


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Basic Features of Corporate Bonds: I

  • issuer promises:

    • coupon payments on designated dates

    • repayment of par/principal/face value of the bond at maturity

  • failure to pay constitutes default

  • ‘trustee’ responsible for ensuring compliance with complex terms of each issue

  • bondholders have prior claim to both income and assets of corporation


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maturity of bonds

often 20-30 years

may exist provisions for early repayment

security for bonds

backed, not just rated

mortgage: creditor gets lien on pledged real assets

collateral trust: as above, but financial assets

debenture: unsecured beyond general right to any unpledged assets

guaranteed: insurance issued by 3rd party

better backed  lower spread

Basic Features of Corporate Bonds: II


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Basic Features of Corporate Bonds: III

  • retirement provisions

    • sinking fund: retire a proportion each year via trustee to lower credit risk

    • do issuers have the right/option to retire prematurely?

    • usually:

      • refunding restriction – cannot for 5-10 yrs with greater seniority, lower interest

      • callable at premium above par: premium declines with time

    • ‘call protection’ stricter: cannot redeem early ever

  • call/timing risk: issuer redeems early


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Jameses: Special Corporate Bond Features

  • convertible bond

    • has call option to convert to issuers’ common stock

  • exchangeable: … to other’s common stock

  • warrant: call options on predefined assets

    • debt with warrant: keep the debt when call assets

  • putable: option to sell back at par on date t

  • zero-coupon: can create from coupon bonds (less real risk?)

  • floating-rate: coupon interest indexed


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Corporate Bond Credit Ratings

  • investment-grade

    • low credit risk, low yield

  • noninvestment-grade (‘junk bonds’)

    • high credit risk, high yield

    • big 80s growth to finance LBOs

    • original issues (70% in US 1992) v. downgraded bonds

    • crowds out bank loans: public doesn’t risk

  • deferred coupon structures: lower early cash pay


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Secondary Corporate Bond Markets

  • exchange market (NYSE, ASE…)

  • OTC market - larger: institutionals

    • brokers carry inventories, tying up dealer capital

    • % dealer capital tied up like this has declined [why?]

    • generally, dealers still in control: prices less transparent, not publicly quoted


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Eurobond Market

  • international syndicate underwrites bond (i.e. buys all from issuer)

  • offered simultaneously to investors in different countries

  • issued outside the jurisdiction of any single country

  • issued unregistered (usually OTC)

  • main currency: $US, but less so

    • can be dual currency: coupon, principal differ


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Preferred Stock

  • like stock, get dividends, but paid at pre-specified ‘dividend rate’

  • missing payments doesn’t bankrupt:

    • cumulative preferred stock: missed dividend payments accrue (if noncumulative, just lose it)

    • imposition of restrictions on management: e.g. gain voting rights

  • US tax code: dividends not as tax-deductible interest payments unless recipient is corporation

    • thus, most preferred stock holders are firms

    • buy s-r preferred to get tax breaks for excess cash

  • usually sinking fund provision; some convertible for common


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Types of Preferred Stock

  • perpetual: no maturity

  • fixed-rate: historical

  • adjustable-rate: dividend reset on T-bills; most perpetual, floor/ceiling on dividend rate; not putable (holder ‘stuck’ with it)

  • auction: as ARPS but auction resets dividend rate

  • remarketed: as ARPS but remarketing agent to ensure sells at par

  • APS and RPS dominant in US since 1985